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Moody's and S&P Cut GM Creditworthiness Deeper into Junk
By James B. Bleeker
On June 20, 2006, Moody's Investors Service cut its creditworthiness rating of General Motors Corporation's long-term unsecured debt to seven notches deep into junk, from "B3" to "Caa1," and Standard & Poor's cut its creditworthiness rating of the same debt to six notches deep into junk, from "B" to "B-." The following table puts General Motors' creditworthiness and the General Motors-Ford race to bankruptcy into perspective.
Table I S&P, Fitch, and Moody's Long-Term Debt Ratings as of June 20, 2006 Ratings Automobile Manufacturers S&P, Fitch Denominations Moody's Denominations Investment Grade Ratings AAA Toyota Motor Corporation AA+ AA AA- A+ Honda Motor Company A A- BBB+ Baa1 BBB Baa2 DaimlerChrysler AG BBB- Baa3 Junk Grade Ratings BB+ Ba1 BB Ba2 BB- Ba3 Ford Motor Company, Ford Motor Company, Ford Motor Company B+ B1 B B2 General Motors Corporation B- B3 General Motors Corporation CCC+ Caa1 General Motors Corporation CCC CCC- Delphi Corporation (GM's jettisoned aggregation of parts plants is in Chapter 11 bankruptcy.) D Moody's and S&P retained their negative outlook on GM's long-term debt, meaning that they may cut GM's debt rating further without advance notice.
The immediate reason for the cut in the rating of unsecured debt is that GM is seeking to extend a credit line farther into the future by offering collateral to the financial institutions providing the revolving credit; this means that there would be fewer assets available to cover unsecured debt, such as bonds, at the time of a reorganization or liquidation. As the extension of credit is from 2008 to 2011, it appears that GM anticipates sizable financial problems for some years to come. Alternatively, GM executives may have concluded that a Chapter 11 bankruptcy is imminently necessary and that tossing bondholders to the dogs is far preferable to being on the outs with bankers.
However, GM's principal dilemma is that for more than a decade, U.S. consumers have been abandoning General Motors' products for the quality products of Toyota Motor Corporation and Honda Motor Company, and in the past two years the pace of this abandonment has quickened, as the following chart helps depict.
As it would likely take decades of determination and effort to significantly narrow the quality gap between the Big Two (GM and Ford) and the Reliable Two (Toyota and Honda) (see The Bottom Line on Auto Reliability), the Big Two are left with but one choice: Cut productive capacity to match dropping demand. Although this is normally a clear-cut business solution that puts things back into balance, it's not for these two. GM's and Ford's current contract with the United Auto Workers obligates them to pay furloughed employees most of their wages (after unemployment benefits are exhausted, per the Wall Street Journal), whether working or not. As a result, General Motors and Ford may exhaust their cash before their contract with the UAW expires in 2007. Without cash to pay their bills, GM and Ford would be forced into bankruptcy reorganization. Once there, their bonds may be converted to shares (preferred, common, or some combination of both), the market value of each of which may be but a small fraction of the face value of the preceding bond.
To help cope with the prospective cash crunch, Ford has sold its Hertz Corporation rental division and General Motors has sold, or is in the process of selling, a majority or all of its stakes in Fuji Heavy Industries Ltd., Suzuki Motor Corporation, Isuzu Motors Ltd. and GM's GMAC finance subsidiary.
GM has also offered more than 113,000 of its employees a buyout - cash to quit - ranging from $35,000 to $140,000. Many employees have accepted the offer; the acceptance likely reflects a concern that GM is too close to bankruptcy to stick around.
Another problem facing Ford and GM, and to a lesser extent other auto manufacturers, is a possible strike at Delphi Corporation, GM's jettisoned aggregation of parts plants that presently supplies both GM and Ford. The strike may result from Delphi's quest to cut wages and close most of its U.S. manufacturing facilities in order to staunch its huge losses and make it a viable business enterprise. As a first step to effect the wage cut and plant closures, it has requested its presiding bankruptcy judge to release it from its contractual obligations to the UAW and its members. In mid-May, the UAW membership authorized a strike in the event that the judge grants the relief that Delphi has requested. If a prolonged strike occurs, GM and Ford would likely exhaust their cash reserves well before their present labor contracts expire and force both into bankruptcy reorganization.
The gap between GM's credit ratings and those of Ford reflects a common assessment by the credit rating services that GM holds a solid lead in its sprint to insolvency.
Source for Moody's and S&P's rating cuts and outlook: "GM's Ratings Cut Deeper into Junk," Reuters, June 20, 2006, available at Yahoo! News and "GM Ratings Cut Further into Junk Status," the Associated Press, June 20, 2006, available at http://news.moneycentral.msn.com
Source for GM's buyout offer: "Automaker's Downsizing Aims to Ensure Survival," Bill Vlasic and Brett Clanton, Detroit News, March 23, 2006, at http://www.detnews.com/apps/pbcs.dll/article?AID=/20060323/AUTO01/603230402/1148
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